It may still be true that the only things certain in life are death and taxes. The first of the two people can understand, but taxes are too complex.
Many in Washington are calling for dramatic cuts in federal spending. Idaho’s own Rep. Raul Labrador is well-known as a spending hawk. But while spending is an issue, how the government raises money may be a more important question. The way taxes are collected has a big effect on the economy’s long-term growth rate.
For the latest fiscal year, the federal government took in just over $2.305 trillion in taxes and other revenue, or about $7,400 per person. About 83 percent of all federal government revenue comes from just two sources - the individual income tax ($1.09 trillion) and social insurance taxes deducted from paychecks ($819 billion). Corporate income taxes, excise taxes and miscellaneous other sources ($400 billion) make up the rest of the revenue.
The current make-up of tax revenue at the federal level is not conducive to long-term economic growth. Our reliance on income and social security taxes distorts incentives and creates unnecessary administrative burdens.
When analyzing tax policies, economists look at how well a given policy raises revenue for the government without distorting incentives for households or businesses while minimizing the burden of complying with the law. These two goals are better met by taxing consumption than income.
Because interest earned and capital gains on investments are taxed at both the federal and state levels, current income tax laws discourage saving. Small business owners that pay higher individual income tax rates are discouraged from reinvesting these earnings. Workers are also discouraged from saving for retirement because Social Security is directly deducted from paychecks.
When a nation taxes consumption, through a value-added tax or sales tax, this disincentive disappears. Surprisingly, many other developed countries rely more on consumption taxes than the United States.
A reliance on individual income taxes also keeps administrative burdens high. Much is wasted in our economy when even the best and brightest in society must hire accountants or tax lawyers to complete the many forms and comply with the ever-changing laws.
In a 2010 report to Congress, National Taxpayer Advocate Nina Olson said the nation spends more than six billion hours a year complying with the federal tax code. This is the equivalent of three million full-time workers.
Idaho has a 7.4 percent top tax rate for both individuals and corporations. More problematic, however, are the multiply exemptions from corporate taxes and numerous individual credits, all of which raise administrative burdens.
Administrative issues aside, economists also worry about how business owners and individuals respond to tax changes. Such activity affects the incidence of a tax. Tax incidence refers to how the burden of a tax is shared, as opposed to who actual pays the tax bill.
Those who bear the burden of a tax are rarely the ones who get the tax bill. For example, most people believe that a tax on luxury yachts is equitable and fair, because people who buy yachts are wealthy. However, the burden of such a tax falls mostly on the people who make and sell yachts when higher taxes reduce production and sales in the industry.
The same is true for high tax rates on individuals with more income. The burden of raising these taxes will fall on the workers these individuals hire or the customers they sell to. The rich simply aren’t burdened by most taxes.
With all else equal, a nation with a tax system that is easy to administer spreads the burden while doing little to distort the incentive to save. It in turn it will have a faster-growing economy.
Government spending is a hot topic this election year, but tax reform should also be up for discussion. Death and taxes are certain, and both should be easy to understand.
Peter Crabb is professor of finance and economics at Northwest Nazarene University in Nampa.